Bio Labs is a genetic engineering firm manufacturing a variety of gene-spliced, agricultural-based seed products. The firm has five separate laboratories producing different product lines. Each lab is treated as a profit center and all five labs are located in the same facility. The wheat seed lab and corn seed lab manufacture two of the five product lines. These two labs are located next to each other and are of roughly equal size in terms of sales. The two departments have close interaction, often sharing equipment and lab technicians. Both use very similar technology and science and usually attend the same scientific meetings. Recent discoveries have shown how low-power lasers can be used to significantly improve product quality. The wheat seed and corn seed managers are proposing the creation of a laser testing department to employ this new technology. Leasing the equipment and hiring the personnel cost $350,000 per year. Supplies, power, and other variable costs are $25 per testing hour. The testing department is expected to provide 2,000 testing hours per year. The wheat seed manager expects to use 700 testing hours per year of the laser testing department and the corn seed manager expects to use 800 testing hours. The remaining 500 hours of testing capacity can be used by the other three labs if the technology applies or can be left idle for future expected growth of the two departments. Initially, only wheat and corn are expected to use laser testing. The executive committee of Bio Labs has approved the proposal but is now grappling with how to treat the costs of the laser testing department. The committee wants to charge the costs to the wheat seed and corn seed labs but is unsure of how to proceed. At the end of the first year of operating the laser, wheat seed used 650 testing hours, corn seed used 900 hours, and 450 hours were idle.

Required:

a. Calculate costs of the two labs, based on the expected hours used by the two labs and on capacity hours.

b. What are the implications of these two alternatives?

c. Discuss advantages and disadvantages of these two cost allocation options.

d. Assess theses two cost allocation option on strategic decision perspective.

e. What are the other issues to be considered in designing cost allocation problems.